As is widely known, very often during the merger and acquisition of companies, a clause called “Earn Out” is discussed. This clause consists of a contractual provision in which the parties agree and consent to the terms of payment for the acquisition.
Earnout is a bilateral agreement in which the purchaser and seller carry out the deal subject to payment conditions based on the future performance of the acquired company.
This conditional payment is linked to the achievement of pre-defined goals, such as revenue, profitability, growth, operational efficiency, cost reduction, expansion of new stores, increase in average ticket per customer, geographical expansion, reduction of operational risk, exploitation of trademark and patent rights, interest in the results of applications owned, including source code and web traffic, as well as user engagement, among other conditions, all established in the purchase and sale agreement.
Therefore, this multifaceted characteristic of the clause has significant implications for the parties, not only in the contractual scope, but especially in the tax area, with repercussions and implications for Corporate Income Tax, CSLL – Contribution on Net Profit, for sellers and purchasers, whether legal entities or individuals.
In this sense, since it is a strategic tool that allows the optimization of the tax burden involved in transactions, it is crucial to analyze the tax complexities in Brazil, together with an assessment of prior tax planning for sellers and purchasers.
As a precaution, it’s important to evaluate both sides of the coin. There are advantages and disadvantages to be considered:
Advantages:
1. Alignment of Interests: The Earnout aligns the interests of the purchaser and the seller, since the final payment is conditional on the future performance of the acquired business. This encourages the seller to maximize the company’s performance after the sale.
2. Risk Reduction for the Purchaser: The purchaser can reduce its financial risk, since part of the purchase price is conditional on the future performance of the acquired company. If performance does not meet expectations, the purchaser can pay less.
3. Financial Flexibility: Earnout allows the purchaser to retain capital and use financial resources more efficiently, since payment is made over time and depends on the company’s future performance.
4. Tax optimization: reduction of tax costs for both sellers and purchasers.
5. Access to Talent and Knowledge: For the seller, Earnout can offer the opportunity to stay with the company for a period after the sale, which can be beneficial for transferring knowledge and ensuring a smooth transition.
Disadvantages:
1. Complexity and Uncertainty: The process of negotiating and implementing an Earnout can be complex and time-consuming, since it involves setting targets, monitoring performance and resolving disputes if targets are not met.
2. Risk of Conflict of Interest: There may be conflicts between the purchaser and the seller regarding the future performance of the acquired company. The seller may seek short-term strategies to achieve Earnout targets, while the purchaser may prefer long-term decisions.
3. Seller’s Risk Aversion: The seller may be reluctant to accept an Earnout agreement due to the risk of not receiving full or partial payment in the future, especially if there are uncertainties regarding the performance of the deal.
4. Tax Impact: The tax treatment of Earnout can be complicated and may result in additional tax implications for both the seller and the purchaser, depending on the structure of the deal and the applicable tax laws.
Comparison Chart
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Advantages |
Disadvantages |
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1. Alignment of Interests 2. Risk reduction for the Purchaser 3. Financial Flexibility 4. Access to Talents and Knowledge 5. Tax Optimization – Tax Planning |
1. Complexity and Uncertainty 2. Risk of Conflict of Interest 3. Seller’s Risk Aversion 4. Tax Impact |
In summary, although Earnout can offer significant benefits, it is important to carefully consider the specific advantages and disadvantages of each situation before deciding to adopt it in a merger or acquisition transaction.
